Grey-market purchases justify taxing only the embedded profit element when sales are accepted and purchases are not fully disproved.

Where sales are accepted and the purchases are treated as having been made from the grey market, the entire purchase value cannot be disallowed as bogus. The reasoning is that accepted sales imply corresponding purchases, so only the embedded profit element saving tax and related costs may be brought to tax. On the facts noted, documentary evidence existed but suppliers were not produced and adverse inference was drawn; still, the business results and sales were not doubted. Applying the same approach as in an earlier year, the disallowance was restricted to 12.5% of the alleged bogus purchases.

---

---

Issues: Whether the disallowance on account of alleged bogus purchases should be sustained at 25% or restricted to a lower percentage where sales were not doubted and the purchases were treated as having been made from the grey market.

Analysis: The assessee had produced documentary evidence of purchases, while adverse inference was drawn because the suppliers could not be produced and because of the assessee partner's statement. The sales and the overall business results were not doubted. In such a situation, the entire purchases could not be treated as non-existent, because accepted sales imply corresponding purchases. At the same time, purchases from the grey market would confer an advantage by saving taxes and related costs, so a reasonable profit element had to be brought to tax rather than the full purchase amount. The Tribunal also noted the consistent approach adopted in the assessee's own earlier year on similar facts.

Conclusion: The disallowance was restricted to 12.5% of the bogus purchases, and the assessee succeeded to that extent.

Ratio Decidendi: Where sales are accepted and purchases are found to be from the grey market, only the embedded profit element can be added and not the entire purchase value.

---